Debt Downgrade: Why Did It Take S&P So Long?

Now that Standard & Poor's has downgraded America's government credit rating, the real questions everyone should be asking are: What took them so long, and why haven't Moody's and Fitch done so as well?

If the U.S. government were not a "sovereign" but a firm, it would have been downgraded long ago. And were this decision in the hands of a political institution -- say, the International Monetary Fund -- we might still be waiting for a realistic diagnosis. But, thankfully, private entities -- even those who, like S&P, have been granted a degree of privilege by the government -- must deal with reality, not the pipe dreams of our politicians.

Thanks goodness that the upstart smaller credit rating agencies seem to have forced S&P's hand. Egan-Jones Rating Co. and Weiss Ratings had already looked at the numbers and downgraded U.S. debt earlier this year. These firms are gaining a foothold as the Securities and Exchange Commission, prodded by the bipartisan Credit Rating Agency Reform Act of 2006, has approved a handful of new firms as "nationally recognized statistical rating organizations" to compete with what had long been the government-protected cartel of the "Big 3."

There's much, of course, to critique in the S&P's downgrade decision. The firm's analysts focus too little attention on how current regulatory policy that slows entrepreneurial growth has exacerbated the crisis. Moreover, they are too quick to accept the Washington mantra that higher taxes would help -- rather than focus on comprehensive reform of our 2.1 million word tax code (less social engineering in the tax code, lower overall rates). And the special powers granted to the established credit ratings firms by the SEC and other financial regulators have embedded their ratings in capital requirements for a host of financial institutions, causing a downgrade to be more damaging than it should be.

Still, S&P realizes it must provide reliable information on how it sees America's financial issues if its reputation is to survive. What it sees isn't pretty: a nation with slow growth, crippling regulations, burdensome tax policies and ever-expanding entitlement and other spending programs. On top of that we have a budget deal that only addresses these problems at the margins, a Republican House reluctant to take on politically sensitive entitlement reform, a Democratic Senate unwilling even to discuss such reform, and a president running for re-election on a soak-the-rich platform.

The ruling class isn't eager for Cassandras telling them that their spending binge cannot go on much longer, yet that is precisely what they need to hear. The last thing we need is Pollyannas to lull the Washington political class back into its usual stupor.

For that reason, the S&P downgrade offers actual hope. As the economist Herbert Stein famously noted: "If something cannot go on forever, it will stop." The current pace of government growth cannot go on forever. The welfare-regulatory state is unsustainable. It promises far more than economic growth makes possible, while its tax, regulatory, and other disincentives to wealth creation make that growth increasingly anemic.

So it will stop. In effect, our political system is now molten rather than broken—it will take a new shape. That presents an opportunity to help shape a re-born America, one that returns to the limited government constitutional ideals that made our nation viable and prosperous. The other option is a future of stagnation, increased poverty, and diminished freedom—things politicians all profess to hate, even as they promote policies that would help bring them about.

Crisis can beget opportunity, as the Cassandras who were once dismissed and the reforms once considered radical begin to be taken seriously. We need not solve all of the problems of the past at once to foster economic growth; simply setting us on the right path can go a long way to reviving innovation and prosperity.

The opportunities are great. Most of the world's wealth has yet to be created. America can again be the entrepreneurial powerhouse if we just let it. We don't need to teach the grass to grow; we simply need to move the rocks off the lawn. Today, the government-created regulatory "rocks" flowing out of the Washington bureaucracy pose the greatest threat to our future -- a threat that, unlike tax and entitlement policy, has yet to receive due attention. S&P hinted at this through its statement in the downgrade explanation that the bickering over fiscal policy "diverts attention from the debate over how to achieve more balanced and dynamic economic growth."

That is where the downgrade creates an opportunity. The unsustainability of the federal Leviathan has grown too large to ignore. S&P has simply recognized the realities which the political class would like to ignore: America's economy is hobbled by ever-increasing government intervention. Only in reversing that trend can there be hope of recovery.